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Euro Decision Shows Limits of Central Bank

By JACK EWING

Published: May 6, 2010

FRANKFURT — Markets in the United States and Europe fell and the euro hit another low for the year on Thursday after the European Central Bank disappointed investors hoping for decisive action to contain the euro zone’s increasingly virulent debt crisis.

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The Dow Jones industrial average plunged 998 points to below 10,000 before recovering to a loss of around 370 points in late afternoon trading. Traders said computer program selling was intensifying the drop.European markets ended lower, with the Euro Stoxx 50 index, which groups euro-zone blue chips, falling 2.5 percent and the FTSE 100 index in London down 1.5 percent. The euro slumped to as low as $1.2522 from $1.2814 late Wednesday.In the absence of a strong European central government, the E.C.B. is the main institution standing behind the single currency with the political independence to act quickly. But the crisis has sorely exposed the bank’s limited powers, and influence, especially compared with its U.S. counterpart, the Federal Reserve. Investors had been speculating that the E.C.B. might take the unprecedented step of buying Greek bonds itself after a €110 billion, or $140 billion, rescue package by the European Union and International Monetary Fund, announced Sunday, failed to soothe fears that Greece would default on its debt. But the president of the central bank, Jean-Claude Trichet, said the subject of a drastic move to reassure markets, like buying government bonds directly, did not even come up at the bank’s regular monthly meeting Thursday, which was held in Lisbon.Deflated investors all but ignored assurances by Mr. Trichet at a news conference that “Greece will not default.” Risk premiums on Greek bonds soared.Markets also took little comfort in Mr. Trichet’s statement that “Portugal is not Greece, Spain is not Greece.” The risk premium, or spread, on Spanish 10-year bonds over equivalent German debt rose to its highest level since the introduction of the euro in 1999, while the spread on Portuguese debt also widened.“I don’t how long it will take them to recognize the seriousness of the situation,” Silvio Peruzzo, euro-area economist at Royal Bank of Scotland, said of the E.C.B’s governing council. The yield, or effective interest rate, on Greek 10-year bonds climbed back to where it was before the bailout — more than 8 percentage points above comparable German bonds. Unlike the Fed, which made huge purchases of bonds to support the U.S. banking system during the financial crisis, the E.C.B. does not have direct links to a government treasury to back up such intervention. As a result, it has less political clout with which to jawbone markets. But analysts say the E.C.B. could still buy bonds on the open market in a move analogous to a currency intervention.Last year, the E.C.B. bought €50 billion in covered bonds, which are low-risk bundles of mortgages guaranteed by underwriting banks, in a successful effort to unfreeze trading in that market. Purchases of Greek bonds “really would be some kind of confidence measure, a signal to the market that default is off the table,” said Marie Diron, chief economist for the Ernst & Young Eurozone Forecast. “That is what the market needs to know.” Mr. Trichet said that the E.C.B.’s council did not discuss buying bonds Thursday. He also disappointed investors who had hoped for a stronger indication that the E.C.B. was willing to take bold steps in response to the debt crisis, as it did during the financial crisis.Some analysts had also speculated that the bank could slow or even reverse its withdrawal of emergency cash from the banking system.Mr. Trichet said only that the governing council was “permanently alert and able to take the appropriate decisions even if they are nonconventional.” He pointed out that the council had moved quickly to erase doubts about whether the E.C.B. would continue to accept Greek bonds as collateral even if they were downgraded further.